explained that the person controlling the S&L (typically the CEO) posed a unique risk because he could use it as a weapon.
The theory synthesized criminology (Wheeler and Rothman 1982), economics (Akerlof 1970), accounting, law, finance, and political science. It explained how a CEO optimized “his” S&L as a weapon to loot creditors and shareholders. The weapon of choice was accounting fraud. The company is the perpetrator and a victim. Control frauds are optimal looters because the CEO has four unique advantages. He uses his ability to hire and fire to suborn internal and external controls and make them allies. Control frauds consistently get “clean” opinions for financial statements that show record profitability when the company is insolvent and unprofitable. CEOs choose top-tier auditors. Their reputation helps deceive creditors and shareholders.
Only the CEO can optimize the company for fraud. He has it invest in assets that have no clear market value. Professionals evaluate such assets-allowing the CEO to hire ones who will inflate values. Rapid growth (as in a Ponzi scheme) extends the fraud and increases the “take.” S&Ls optimized accounting fraud by loaning to uncreditworthy and criminal borrowers (who promised to pay the highest rates and fees because they did not intend to repay, but the promise sufficed for the auditors to permit booking the profits). The CEO extends the fraud through “sales” of the troubled assets to “straws” that transmute losses into profits. Accounting fraud produced guaranteed record profits-and losses.
CEOs have the unique ability to convert company assets into personal funds through normal corporate mechanisms. Accounting fraud causes stock prices to rise. The CEO sells shares and profits. The successful CEO receives raises, bonuses, perks, and options and gains in status and reputation. Audacious CEOs use political contributions to influence the external environment to aid fraud by fending off the regulators. Charitable contributions aid the firm’s legitimacy and the CEO’s status. S&L CEOs were able to loot the assets of large, rapidly growing organizations for many years. They used accounting fraud to mimic legitimate firms, and the markets did not spot the fraud. The steps that maximized their accounting profits maximized their losses, which dwarfed all other forms of property crimes combined.
While agreeing that the S&L served as both a “weapon” and a “shield,” control fraud theory cast doubt on those metaphors. Weapons and shields are visible; fraud is deceitful. The better metaphors would be camouflage, or a virus. Control fraud theorists rejected the economists’ metaphor, “gambling for resurrection” (honest but unlucky risk takers). Gambling cannotexplain why control fraud was invariably present at the typical large failure. There were over 1,000 felony convictions of senior S&L insiders. Accounting fraud made control fraud a sure thing-not a gamble. Control fraud theory predicts the pattern of record profits and catastrophic failure and the business pattern of deliberately making bad loans. Both patterns are inconsistent with honest gambling.
Thursday, November 11, 2010
The Control #Fraud Theory | Bizcovering @hubbit @rockingjude @firetown @mparent77772 #corruption
via bizcovering.com
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